Powell Wants to Savor Victory Patiently, Which Probably Means Waiting a Bit Longer

Powell Wants to Savor Victory Patiently, Which Probably Means Waiting a Bit Longer

Key takeaways

• The most newsworthy line was Chair Powell saying, “I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting to identify March as the time to [cut], but that’s to be seen.” There were strong reasons for Powell not to pre-signal a March cut, even if it had been his baseline, but this was a much more definitive statement than I expected.
• While Powell said that March is not the base case, between the still present risks of downside surprises in the labor market (even if not ultimately cyclically meaningful ones) and good inflation data continuing in such a way that it eases their concerns sufficiently, the odds of a March cut seem to be roughly 25% to me now.
• Over the next few weeks and months, we are likely to see more policy-driven volatility. Given the possibilities of Fed communications dispersion, inflation data which could go a myriad of directions, CPI and labor market revisions, and noisy labor market data, near-term rates vol seems likely to be high. The range of plausible cutting scenarios, even with roughly base case data, is quite wide.
• This seems to inject more path risk into markets than it does increase the odds of overall negative macroeconomic outcomes over a longer cyclical horizon. March vs May vs June is not likely to be the issue which ends the cycle, assuming the Fed remains appropriately nimble as the data actually come in.
• Today’s events haven’t really shifted my odds of cumulative cuts this year too much; if before (in a roughly normal economic environment) it was a baseline of 4 with risks skewed to 3, now that perhaps feels more like 3 with a solid risk of 4.
• The Fed wants not lower (in a m/m or 3m sense) but simply more good inflation data. As Powell said, “we do have confidence, and it has been increasing, but we want to get greater confidence… it’s not that we’re looking for better data it’s that we’re looking for a continuation of the good data,” before they will feel comfortable starting to ease. What exactly that looks like remains to be seen and I suspect that almost every public appearance by Fed officials over the next 5 weeks will include a question asking exactly how their confidence has evolved since this meeting.
• While there is only one more CPI report between the March and May meetings (we get two more + CPI revisions before March), the fairly strong lean against March suggests some combination of: elevated uncertainty about the inflation forecast having been burned before despite the recent data, intra-committee disagreements best smoothed over in a hawkish direction, or a fundamental caution about being perceived as moving too soon (in an almost data independent sense).

A Few More Detailed Thoughts Across the Outlook, Press Conference, and Statement

• The Committee seems to have a substantial degree of near-term inflation risk aversion. Powell seemed quite scarred by last year’s CPI seasonal factor revisions, saying “last year was [caugh] a surprise.” A clearly unpleasant and unexpected one at that. In addition, the implicit concern embedded here suggests that while some core goods deflation is expected to continue there’s an underlying degree of caution in assuming any absence of upside inflation noise before starting to ease, “I think the more likely risk is that you’ve had 6 very good months…. Are the last 6 months flattered by one-off factors that won’t repeat themselves? … We want to get comfort on that.” One way of interpreting that view is that the Committee is ok cutting into a bit of a bounce in core services ex housing inflation but doesn’t want to have the overall core measure bouncing on a m/m or 3m saar basis, even if longer-run measures are continuing to move down.
• Saying that “we look at the whole number” when assessing inflation is fairly clearly dovish in the present context but more data seems to be required there to feel sufficiently ok with its path. The Chair referenced inflation internals’ in quite a minimally hawkish way (core goods slowly normalizing back to 0 and fearing upside surprises or the risk that the past few months’ good news has been ephemeral), which seemed like it would have been the easiest out and way to lean against any sort of near-term dovishness if he had wanted.
• There seems to be a bit of a general annoyance, which seems somewhat justified in my view, with Powell’s framing on the reasons to lean against March. Given that on top of the very good PCE inflation data over the past 6m, on a forward-looking basis he acknowledged that average rents are coming down, wage growth and the labor market seem to be slowly normalizing, inflation expectations largely at target consistent levels or close to, and having 2% y/y inflation in hand is not necessary for, or advisable in many FOMC participants views, before starting to cut, what is gained by waiting an extra month or two? Of course, March was nowhere near locked in before today (I had said 50% or a bit below) but the logic combined with the outlook suggest some hesitancy which seems hard to justify based purely on the articulated reasons.
• Between now and March is as much time as was between it being premature to start discussing rate cuts and when the full Committee started discussing them in public, so one should be appropriately skeptical of any time-based commitments from the FOMC. But Powell was explicit enough that the lean against March seems to be a bit more committed but there is still some element of data dependent risk management which keeps odds of March alive, if notably lower than they were this morning.
• Powell’s pushing back on March in the way he did implies a bit of an extra hawkish residual in the reaction function. One could fairly say that with rates expected to have only a quite gradual descent from here that has always been there, but it seemed more apparent today than it had since early December.
• Come March it seems possible, or even probably, that the Committee’s 2024 core inflation forecast likely has to be revised down slightly given their usual forecasting approach (whether or not growth will be revised up seems a bit more of a theological question). If this happens, it will beg further questions about why the FOMC chose not to cut then but that’s a possible problem for the Chair in the future, not the commentator’s box.
• Ultimately, the lean against March may be nothing more than necessary intra-committee politics, keeping the more hawkish members happy with a lot of uncertainty about the data to come and little assessed risk to the outlook from waiting an extra meeting or two.
• Powell seemed relatively unconcerned by current levels of wage growth, saying that “the evidence is that wage increases are still at a healthy level… but they’re gradually moving towards levels” that are more consistent with inflation at target given standard productivity assumptions.
• With the risk of outright inflationary deanchoring much less of a concern than it once was, the Committee is now much more growth tolerant than it was in 2022-23, with Powell saying, “we don’t look at stronger growth as a problem. We don’t want to see a weaker labor market. We want to see inflation coming down.” This is a substantial shift over the past few months and does highlight the desire, not yet acted upon, to return towards more 2019-like reaction function, even if some of the underlying economic concerns have durably shifted since then.
• Powell acknowledged that, “we don’t know with great confidence where the neutral rate of interest is at any given time.” This naturally leans towards increasing data dependence in the policy process but that was not necessarily the tone of the rest of the press conference.
• Despite the Chair’s acknowledgement that some parts of the economy seem to be gaining greater confidence and that interest rate sensitive sectors (housing) seem to be stabilizing, the Fed seems to continue to place a very high weight on spot real rates and long policy lags. In the near-term this is a bit dovish but over the longer-term the forecast implications of the Fed being too pessimistic on growth make it a bit hawkish.
• The Chair’s framing of recent growth outperformance was that it was largely due to supply side healing and that “when that [supply side healing] peters out, I think the restriction will show up probably more sharply.” This a fairly strong degree of anchoring on real fed funds rate view of policy transmission which I think was at least partly rebutted by a number of his other comments (mentioned above).
• Despite the Fed’s framing, and some possibility of near-term volatility in rates markets, I continue to think that financial and borrowing conditions are easing relative to the 23Q2-Q3 levels, supporting growth on the margin.
• There was little to no sign of concern about some of the increasing noise or dispersion in the labor market data. While I agree with this readthrough, I was a bit surprised that some of the recent signs of concern merited no mention all (which did take away of a bit of the dovish case for March). Perhaps this means that staff analysis has persuaded the FOMC there’s no underlying cause for concern, but I worry that this means that the FOMC is just a bit less attentive to that downside tail (always present in mid-to-late cycle labor markets to some extent) which has been highlighted more in the past few months. This isn’t to say that my underlying optimistic view has shifted, but rather that as a policy maker I’d perhaps be a bit more attuned to trying to truncate away that non-linear tail in the present moment.
• One somewhat inescapable conclusion of the day is that Governor Waller’s December comments on cutting criteria, were perhaps reasonable to him but seem to imply greater confidence in his own forecasts and the data than the Committee as a whole has. Perhaps this is not too surprising given his at the time quite out of consensus views on the likelihood of layoff-less labor market easing in May 2022 but it is notable going forward.